Virginia is moving to regulate an expensive small business financing option

A complicated and often expensive financing option for small businesses will become easier to follow with an order from the State Corporation Commission dictating what providers must tell consumers.

An option called sales-based financing is a small business cash advance that the small business repays with a certain portion of daily sales.

Basically, the deal, also known as a merchant advance payment (MCA), means that if a small business’s sales are slow on a given day, its payment that day will be less.

But the real price can be high and the deals can be tough enough to understand that Del. Kathy Tran, D-Fairfax, thought some standardized disclosures would be a good idea.

“They can be very complex and very confusing,” Tran said.

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And it’s easy for people to get in over their heads — she said she heard that from an attorney who works with Asian American businesses in Northern Virginia to find out about such offers.

“Many restaurants in Richmond were affected; there was one who settled an MCA and when the pandemic hit his business he couldn’t make it and so he took out another MCA to pay off the first one and it almost went bankrupt,” she said.

The General Assembly unanimously agreed with Tran’s argument that small businesses deserve some protection — making Virginia one of only four states, along with California, New York and Utah, to do so.

The SCC has now approved regulations that require sales-based financing firms to make specific disclosures about finance charges, total payout amount, estimated number of payments and payment schedules, and several other critical terms.

Virginia also now prohibits “judgment recognition” language in many of these deals, which precludes going to court to resolve disputes about what has been paid and what is still owed.

Tran’s Law states that arbitration of disputes must take place in Virginia, not out of state, as some sales-based financing agreements require.

And it says companies offering this kind of financing must register with the SEC so it and the General Assembly can stay on top of a kind of deal that’s been well under everyone’s radar.

One major player, the sales-based financing unit of PayPal Inc., told the SCC’s Bureau of Financial Institutions that it provided nearly $19 million to 1,143 Virginia small businesses last year.

About 70 percent of his advances were to borrowers in counties that lost 10 or more bank branches after the 2008 recession, and more than a quarter of his advances were to businesses in low- and moderate-income areas, Bernardo Martinez , PayPal’s vice president of global commercial lending, the SEC said.

The basic idea has been around since the late 1980s in the form of a three-party transaction whereby the advance would be repaid out of a fixed share of the company’s future credit card receipts, with the credit card company processing and paying the split between the company that made the advance, and the merchant who made the sales.

For many small businesses, this meant it was easier to get funding, as the cash flow of the business, rather than the owner’s personal credit rating, mattered.

But just like with a credit card, when the consumer only makes the minimum payment, the real cost can turn out to be much more than initially thought.

In addition to paying the down payment, small businesses must pay what’s called a “factor,” which is often between 20 percent and 50 percent of the down payment, according to a recent Federal Trade Commission report.

“MCAs have very high costs – including, in some cases, estimated APRs in the triple digits. As a result, many business owners who receive MCAs may find it difficult to pay them off successfully,” the FTC said, referring to the annual percentage rate for credit transactions.

Sometimes the MCA provider’s daily withdrawal from the business’s bank account does not match what the business has seen in revenue for that day. That’s the subject of a lawsuit by a New York healthcare startup against its firm, MCA.

Because the business owner signed an “acknowledgment of judgment” waiving the right to go to court, the MCA firm at the same time received a court order demanding payment of $800,000, according to a recent report by The City, a New York online news outlet. edition.

The FTC report said it heard concerns that some MCA providers engaged in aggressive and potentially misleading marketing practices, often paying large commissions to brokers who close deals.

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